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Judgment
Balasubrahmanyan, J.—One Georgepolous was carrying on business in the export of hides and skins. It was his sole proprietary concern.
On December 11, 1964, a firm of four partners (hereinafter called the ""assessee-firm"") purchased this business for Rs. 50,000. Under the terms of
purchase, the assessee-firm was entitled to carry on the business of export from where Georgepolous left off. In other words, the take-over by the
assessee-firm was of the concern as a whole including goodwill, trade-mark and import and export quota rights as well as the trade outstandings
and trade debts.
Subsequent to the take-over of the business and the carrying on of the business by the partnership concern, some of the foreign buyers, to
whom goods had been earlier supplied by the erstwhile sole proprietor, found that deliveries to them had been under short-measurement. When
this came to the notice of the firm which purchased the undertaking as a going concern, they came forward to settle the claims of the foreign
buyers. The claimants included the U. S. SR. Trade Representative and two firms in the U. S. A. The payments made by the firm towards meeting
the claims by these foreign customer amounted in all to Rs. 1,28,384. This amount was paid by the firm in the account year ended December 31,
1965. In their relevant assessment to Income Tax for the year 1966-67 the firm claimed the payment of Rs. 1,28,384 as a business outgoing. The
ITO rejected the claim and added back the amount while making the assessment. This assessment was confirmed in appeal by the AAC. The
assessee appealed further to the Tribunal. The Tribunal held that the amount paid was an item of business expenditure wholly and exclusively
incurred by the assessee-firm for the purpose of their business. The Tribunal further held that the expenditure was not of a capital nature.
Aggrieved by this decision of the Tribunal, the Department demanded a case from the Tribunal. The Tribunal complied with this requisition and
made a reference to this court on the following question of law :
Whether, on the facts and in the circumstances of the case, Rs. 1,28,384, beign the aggregate of the amounts paid by the assessee during the
relevant previous year to the Trade Representative of the U.S.S.R. in India, Bombay, M/s. Fleming and Toffee Ltd., New York, and Allied Kid
Company in satisfaction of their claim for compensation for short-weight delivery of the skins sold to them by its predecessor in business should be
allowed as expenditure allowable u/s 37 of the Income Tax Act, 1961, for the assessment year 1966-67 ?
Mr. Jayaraman, learned standing counsel for the Department, addressed his arguments on two distinct aspects of the question, namely, the one
raising the issue as to whether the amount paid by the assessee-firm to the foreign buyers can be regarded as an outgoing wholly and exclusively
for the purpose of the assessee''s business, and the other as to whether the expenditure, even if it were an item of business outgoing for the purpose
of the assessee''s business, was not an item of capital expenditure.
On the first question, the learned standing counsel referred to a clause in the written agreement of sale dated December 13, 1964, entered into
between the assessee-firm and the erstwhile sole proprietor of the business. That clause reads as under :
The purchaser shall pay, satisfy, the discharge and fulfil all the debts, liabilities, contracts and engagements of the business of the seller, in relation
to or in connection with the said business and shall indemnify the seller against all proceedings, claims, demands in respect thereof and shall be
entitled to all profits and losses from 14th December, 1964"".
As earlier mentioned, the date, December 14, 1964, marks the day from which the assessee-firm began carrying on the business which was a
sole proprietary concern of its previous owner. The gist of this clause, however, seems to us to be merely a reiteration of the obvious, namely, that
with the sale of the business by its sole proprietor to the assessee-firm, the business becomes entirely that of the assessee-firm and it is the
assessee-firm which thereafter has got to take both the lean with the fat, as the saying goes.
The learned standing counsel then urged that these payments made by the assessee-firm to the U.S.S.R. Trade Representative and the two
American firms were not made in discharge of any liability of the assessee''s own, either contractual or otherwise. He pointed out that the claims of
these purchasers arose out of short deliveries effected by Mr. Georgepolous at a time when the business was that individual''s sole proprietary
concern. The learned counsel accordingly urged that the liability to answer the claims of these buyers, if at all, would be only that individual''s as the
then proprietor of the business. The point which the learned counsel wished to make was that it was not necessary for the purposes of the
assessee''s business, either under contract or under any other legal obligation, to discharge the claims made by its predecessor''s buyers. Since
there was no legal necessity for the payment, the money laid out, according to the standing counsel, cannot be allowed as the assessee-firm''s own
expenditure in business.
The argument of the learned counsel is easily met by reference to the statutory requirement for allowance of business expenditure under the
residuary head of allowance laid down by s. 37 of the I.T. Act, 1961. Under this head, there is no requirement that an item of expenditure or
outgoing must be incurred or laid out with a view to earn the profits; nor is there any requirement that the expenditure must be incurred in order to
meet an obligation arising either out of a commercial contract or out of any provision of law or custom. All that the section requires is that the
expenditure must be incurred or laid out wholly and exclusively for the purposes of the assessee''s business. A provision of this kind has been there
almost ever since Income Tax law came to stay as part of our fiscal system. In the United Kingdom, the profits of trade of a taxpayer are to be
computed in accordance with Sch. D. One of the rules of Sch. D is to the same effect as s. 37 of our Act. Even in our earlier Indain I.T. Act of
1922, s. 10(2)(xv) employed the same phraseology, and allowed all expenditure wholly and exclusively incurred or laid out for the purposes of the
assessee''s business. It is true that the provision as it existed before 1939 in the Indian I.T. Act, 1922, did use language which was appropriate to
the argument now being advanced by the learned standing counsel, namely, that the expenditure must have been incurred ""in order to earn the
profits"". But this phraseology, which characterised the relevant provision in the Act of 1922 before its amendment in 1939, yielded place to the
more acceptable test of ""wholly and exclusively for the purposes of the business"". The requirement that expenditure must earn the income in order
to be deductible is, however, still retained in the Income Tax code in the matter of computation of taxable income under the head ""Other sources"".
The test of allowability under this residuary head of income is that the expenditure must be for the purpose of ""earning or making"" the income.
However, this is quite a different requirement from that laid down by s. 37 which does not expect the expenditure to satisfy any condition other
than that it should be incurred for the purposes of the business and wholly and exclusively for these purposes.
In Atherton v. British Insulated and Helsby Cables Ltd. [1925] 10 TC 155 (HL), which is an oft-quoted case in a discussion of this kind,
Viscount Cave reiterated the position that a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the
trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be
expended wholly and exclusively for the purposes of the trade. This dictum of Viscount Cave is now the preferred doctrine as contrasted with the
narrower view of the provision for allowance which was propounded again, in a very oft-quoted passage in tax discussions, namely, that of Lord
Davey in Strong and Co. of Romsey Ltd. v. Woodifield [1906] 5 TC 215 (HL). In that case, Lord Davey construing the relevant rule in Sch. D of
the United Kingdom Income Tax Act, observed that (p. 220) :
It is not enough that the disbursement is made in the course of, or arises out of, or is connected with, the trade for is made out of the profits of the
trade. It must be made for the purpose of earning the profits.
Even in the United Kingdom, this view of the deduction provision is not now much favoured. Indeed, the Royal Commission on the Taxation of
Profits and Income, in its final report, made a pointed criticism of the expression of opinion contained in Lord Davey''s judgment. The Commission
observed that Lord Davey''s words amount to a gloss upon the statutory words "" wholly and exclusively for the purposes of the trade."" In the
opinion of the Royal Commission, ""for the purposes of earning the profits"" cannot be a good interpretation of ""for the purposes of the trade"", since
the earning of the profits imposes a limiting condition for the expenditure, and this makes for an unduly narrow construction of the statutory
provision. The Royal Commission, however, recognised that Lord Davey''s words had so often been quoted in judgments and they had almost
come to enjoy the status of a new definition added unto the statutory one. They expressed the view that the statutory rule would be better
administered if the gloss of Lord Davey could be entirely forgotten.
In our own country, the two view points about the requirement of business expenditure had been the subject of examination as to their validity.
In the case of Commissioner of Income Tax, Kerala Vs. Malayalam Plantation Ltd., , Subba Rao J., as he then was, expressed a preference for
the view reflected in Viscount Cave''s judgment. The learned judge observed that the expression ""for the purposes of the business"" is wider in
scope than the expression ""for the purpose of earning profits"", and adopted it as the test of expenditure allowed under the statute.
In the present case, it is true that the assessee-firm was not under an obligation, either under the terms of the agreement dated December 11,
1964, or under any provision of law of of custom, to meet the claims for shortage for those who had purchased the goods from the former sole
proprietor of the business. But it is quite clear that these payments were made by the assessee for the purpose of preserving the custom and
improving it, having regard to the fact that they had taken over the export business as a going concern, retaining even the same business name as
before. The Tribunal observed that the assessee-firm felt it necessary to keep up the business reputation, especially when they had acquired the
right to use the same trade name as was used by the predecessor in the business. We are, therefore, satisfied that although there was no legal
obligation on the part of of the assessee-firm to make these payments, the expenditure having been incurred as a matter of business expediency,
must be held to have been incurred wholly and exclusively for the purposes of the trade. The learned standing counsel did not suggest that there
could be any purpose other than a business purpose, for the incurring of this expenditure.
We are also satisfied that the expenditure cannot be regarded as not relating to the assessee''s business merely for the reason that if the claims
had been enforced, they would, in all propriety, be enforced not against the assessee-firm but only as against the former owner of the business,
because they related to that period. That the claims related to the sole proprietary business and not to the assessee-firm and related to an earlier
phase of the concern, is only another way of arguing that the assessee-firm was not bound, as of necessity, to meet these expenses. But if the
element of commercial expediency was fully present, as the assessee-firm''s sole motivation, and this has been pointed out by the Tribunal with
reference to the need to keep up to business reputation and the like, then the fact that the claims related to a period when the business was that of
the sole proprietor cannot make for the disallowance of the expenditure under s. 37 of the I.T. Act.
The next argument which the learned standing counsel addressed was that this expenditure was, in any case, capital in nature. In this argument,
the learned counsel made an attempt to establish that, in some way, this payment of Rs. 1,28,383.85 made by the assessee to the trade
representative of the U.S.S.R. and the two firms in the United States really formed part and parcel of the aggregate purchase price agreed to be
paid by the assessee for the acquisition of this business as a going concern. This argument, however, cannot be tenable on the fact found in the
case. For, it was not part of the terms of the agreement of take-over of the business that the assessee should meet the claims of the clients of the
former sole owner of the firm. Indeed, as the Tribunal pointed out, these claims for short delivery came to the surface only subsequent to the take-
over of the business by the assessee-firm. The suggestion is that they might not have been anticipated at all either before or at the time when the
business was transferred as a going concern by the former owner in favour of the assessee-firm. Apart from this consideration, the mere fact that
certain liabilities are taken over by the assessee along with a business which it acquired for consideration, cannot, in all cases, lead to the
conclusion that the value of the liabilities must also be regarded as forming an integral part of the purchase price and be regarded as payment under
capital account. In our judgment, the real nature of an outgoing represented by the discharge of the liabilities attached to a business which an
assessee acquires for consideration would depend upon whether the liabilities themselves could be related to the revenue account or to the capital
account, as the case may be. In the present case, there is no doubt whatever that the amounts aggregating to Rs. 1,28,383.85 were paid by the
assessee to the trade representative of the U.S.S.R. and other parties only in respect of dealings under the trading account which were earlier
entered into by them with the former owner of the business. They arose in respect of purchases of skins made by them from the sole proprietary
concern. Their only claim was that in effecting the deliveries, there was short supply and under the terms of the contract they were entitled to be
paid the value of the extent of the short supply, as compensation or damages. Such compensation, therefore, would partake of the same character
as a revenue outgoing, since they only go to offset the purchase price of the goods already paid by the foreign buyers to that extent. In these
circumstances, when the assessee paid these moneys due to the foreign buyers for the purpose of meeting their claims on short delivery, what the
assessee did was to make payments only under revenue account and not as part and parcel of the aggregate purchase price for which they had
acquired the entire business as a going concern.
Mr. Jayaraman referred to some decided cases in which an assessee having acquired an existing business had made a payment to the former
owner, or to the former owner''s account and claimed the payment as a deductible item of expenditure in the computation of his own subsequent
profit from the acquired business. Where the payment is made straightaway to the vendor, it is part of the price for acquisition of the business, and
hence capital expenditure. But where the consideration consists in the discharge by the purchaser of a liability of the vendor, the payment would
still partake of the character of capital expenditure, because the discharge of the vendor''s liability is part of the agreed purchase consideration. The
line of cases cited by the standing counsel on this point included Commissioner of Income Tax, Delhi (Central) Vs. D.L.F. Housing Construction
(P.) Ltd., , of the Delhi High Court; V.N.V. Devarajulu Chetty and Co. Vs. The Commissioner of Income Tax, , of our High Court and Western
Mechanical Industries Pvt. Ltd. Vs. Commissioner of Income Tax, Bombay City-I, , of the Bombay High Court. The present case, however, is
quite different and distinguishable from all these cases as a fundamental difference in the fact situation. The payment by the assessee of Rs.
1,28,384 was not to the former owner of the business. There was not even a mandate from the vendor that the claims for short delivery were to be
met by the assessee. These payments were made by the assessee quite otherwise, and de hors the purchase consideration. They were made in the
course of the assessee firm''s own business, to secure the firm''s good name and custom. Its nature as a deductible item of expenditure must, in our
judgment, be regarded as much the same as it would have been if the sold proprietor had continued the business, had made those payments himself
and had claimed then as proper trading expenses or losses in his business. The fact that the business had changed hands cannot make for a
different conclusion.
Cooke (H. M. Inspector of Taxes) v. Quick Shoe Repair Service [1949] 30 TC 460 (KB), is an English case. But we regard it as very near
to the present case. Hence we would adopt its general reasonings. The taxpayer in that case was a partnership firm. It purchased an existing shoe
repair business. Under the agreement of sale, the trade outstandings were to be paid by the vendor. Those debts and outstandings included
amounts payable to those who supplied leather, rent for the business premises, wages to workmen and the like. All of those items would have been
proper outgoings in the revenue account if they had been paid by the former owner. The taxpayer was not to be bothered by these trade debts.
Actually, however, the vendor whose responsibility it was to clear them, did not pay them off. The result was that the taxpayer as purchaser of the
business had to come forward to clear the debts, if only to ensure the maintenance of supply of raw materials to him, the continuation of the
accommodation of the shop premises and the retention of the services of the employees. Having accordingly made the payments, the taxpayer
claimed them as part of his deductible expenses for Income Tax purposes. The question arose whether he was entitled to do so. Croom-Johnson
J. decided the issue in favour of the taxpayer on both the points, one on the point whether the expenditure was wholly and exclusively for the
purpose of the assessee''s trade and the other on the point whether it was an item of revenue or capital expenditure. On the first point, the learned
judge relied on the dictum of Viscount Cave in Atherton v. British Insulated and Helsby Cables Ltd. [1925] 10 TC 155 (HL), and held that in the
circumstances of the case, even though the taxpayer was under no legal liability to make the payments, he had done so with a view to preserve his
business. The learned judge was not unalive to the possibility that the taxpayer-firm, as between its own partners, might choose to record these
outgoings as being under capital accounts. But all the same he held that in the computation of the taxpayer''s trading profits for purposes of Income
Tax it would not be incorrect to record the outgoings as falling under the revenue account, since the payments were made in order to ensure the
continuance of supplies, of the working force and of the shopping accommodation.
As we earlier indicated, we derive substantial support from this English decision. There is only a minor difference, on fact, between that case
and the one before us. But the difference is quite immaterial for a decision on principle. In the case before Croom-Johnson J., the sale agreement
expressly reserved the trade liabilities, as on the date of the transfer, as liabilities to be discharged by the vendor. In the agreement in the present
case, there is no such express term, but, as a matter of construction of the terms of the sale, it could not be suggested even in the present case that
the claim by the foreign buyers for shortfall in delivery was either contemplated or provided for to be met by the assessee-firm. The principle of the
Quick Shoe Repair Service case [1949] 30 TC 460 (KB), must, therefore, be applied to the present case without any qualification.
The learned standing counsel cited a decision of the Punjab and Haryana High Court in Dashmesh Transport Co. (P.) Ltd. Vs. Commissioner
of Income Tax, . From the report of this judgment it would appear that there was a purchase by the assessee-company in that case of the assets
and liabilities of a transport company under the terms of which certain liabilities had to be discharged by the purchaser-company. In a short
judgment, the High Court came to the conclusion that the value of the liabilities discharged by the assessee-company formed part of the very
consideration for the acquisition of the business. On this ground, they held that the amount which went in for discharge of the vendor company''s
liabilities, was capital expenditure, not entitled to deduction. We do not think this decision affords any guide for taking a decision in the case before
us. On the brief statement of facts contained in that judgment, it would seem that the decision of the court rested on the finding that the very
purchase price for the acquisition of the business in that case comprised an obligation on the purchaser''s part to discharge the vendor''s liabilities.
That position, as we have earlier explained, is not the case in the reference before us.
For all the above reasons, we hold that the Tribunal was justified in holding that the payment of Rs. 1,28,384 by the assessee was an
admissible deduction under s. 37 of the I.T. Act, 1961. The question of law referred to us is accordingly answered in the assessee''s favour had
against the Revenue. The Department shall pay the costs of this reference to the assessee. Counsel''s fee Rs. 500.